The Bond Market Has Already Priced In Tapering, And Now The Question Is: How Much More Damage Will There Be?

Yields on U.S. Treasuries have soared since May 3 as bonds have
sold off and investors have yanked money out of bond funds,
driven by fears that the Federal Reserve would begin to signal
tapering back of the bond purchases it makes under its
quantitative easing program of monetary stimulus sooner rather
than later.

Today, the Federal Reserve
Chairman Ben Bernanke had the opportunity to push back against
the rise in rates and allay market volatility, which is exactly
what the market consensus expected of him.

Bernanke
ended up doing the opposite – he essentially encouraged the
rise in yields, saying it was for good reasons – and investors
began dumping bonds, sending the yield on the 10-year Treasury
note to 2.35% at the close, up 14 basis points from where it was
before the release of the FOMC monetary policy statement and
subsequent Bernanke presser this afternoon.

The natural question, as UBS
economists led by Maury Harris put it, is this: How much
more bond market damage?

Harris and his team actually think Fed tapering has already been
priced into the market:

The benchmark 10-year Treasury note yield already has risen from
1.66% at the start of May to 2.35% soon after the Fed's latest
communications. As earlier mentioned, we have raised our 10-year
Treasury note yield forecast for year-end 2013 by 30 basis points
to 2.5% but are maintaining our 2.8% forecast for the end of
2014. Why not more damage than that to an already damaged bond
market? Most importantly, we think that the bond market
already has priced in tapering. Second, the Fed is
reiterating that it will not even consider raising the Federal
funds rate until unemployment is at a 6.5% threshold. Also,
Bernanke's theory that bond yields will reflect how much
securities the Fed holds (the "stock" theory) versus how much
they buy (the "flow" theory) probably has at least some, albeit
quite controversial, validity.

If that's the case, maybe the bond market has already put the
scariest part of the tapering story behind it.